Analysis & Opinions

Linda Bilmes: Dissecting Coronavirus Economic Impact and Recovery Options

| May 07, 2020

Excerpt: Linda Bilmes on local government and small business choices

HOW DO WE AVOID a disastrous humanitarian crisis in developing countries as we emerge from the pandemic lockdowns? Will economic justice be harder or easier to attain after COVID-19? How do we get our nation back to work? Should we focus on the surging federal debt?

We asked several faculty members at Harvard Kennedy School for their insights on the central economic challenges as the United States and the world shift toward the recovery phase of the crisis. The ideas these scholars offered can assist political leaders and administrators who are making policy decisions at the federal, state, and local levels.

State and local governments can lead the recovery

State and local governments provide essential services such as schools, water, sewerage, trash collection, public transit, police, fire, and emergency medical care. They face an immediate liquidity crisis and a long-term revenue shortfall due to declining tax revenues, user fees and grants, as well as new headwinds in the municipal bond market—a “perfect fiscal storm.” Unlike the federal government, states must balance their budgets. It took them five years to recover from the 2008 financial crisis. This time will be even worse. The Congressional Budget Office predicts that their collective budget shortfall over the next three years will reach $650 billion—twice the size of 2008. States receive about 45 percent of their revenue from income taxes and the rest from sales and other taxes and fees. But there is a great deal of variation among the states, depending on their financial condition pre-COVID-19 and their mix of revenue streams. Louisiana and Florida, for example, will be especially hard hit due to their heavy dependency on sales taxes, underfunded pension obligations, and low level of reserves. Local governments, including cities, towns and counties, face significant reductions in the amount of aid they receive from the states.

Such intergovernmental transfers account for 40 percent of their revenues. In 2008, cities compensated for this shortfall by raising revenues from property taxes, sales taxes, and fees. This time is completely different, and they don’t have many options. Raising property taxes or increasing tolls, parking fees, or airport landing charges is unlikely to yield significant revenue given there is less travel—but it will pile more pressure on the local economy, thereby jeopardizing the future tax base.

Local governments also face a more difficult borrowing environment. For the past decade, cities have enjoyed easy access to the municipal bond market at low interest rates to finance capital improvements such as roads and bridges. However, the bond market has changed overnight, as bond investors view the new financial risks facing cities. Even if local governments do manage to retain their bond ratings, it will be more difficult and expensive to raise fresh capital.

Local governments are also the front line in terms of helping small businesses, which are the lifeblood of their communities. The federal stimulus has provided a bridge to help small businesses stay afloat for about three months, but restaurants, hairdressers and car repair shops don't have the ability to survive for long without customers. Even if federal government enacts a further stimulus targeted to state and local governments, it won’t be sufficient to prevent painful cuts at the local level.

Given these extraordinary circumstances, what can local governments do?

First, like doctors, they should do no harm. For their operating budgets, instead of across-the-board cuts and layoffs to reduce spending, cities should use an activity-based approach. Activities within each department must first be reviewed and those with lower priority can be reduced or eliminated, rather than across-the-board cuts. Convening a local control board can assist in making difficult trade-offs.

Second, communities need to adjust the way they budget, planning at the outset for a worst-case scenario, then examining variances on a monthly basis and adjusting the budget as new information comes in.

Third, local governments need to defer non-essential capital spending and, where possible, refinance outstanding debt at lower interest rates. To lay the groundwork for recovery, retaining access to capital markets should be a priority and mayors should engage with their investor community to show they have a plan to keep their finances under control. In Massachusetts, State Treasurer Steve Grossman successfully shifted $4 billion in state bond holdings from Wall Street to Main Street, seeding community banks, which in turn helped to revive communities after 2008. This should be a role model for states and cities this time around.

For more information on this publication: Belfer Communications Office
For Academic Citation: Bilmes, Linda.“Linda Bilmes: Dissecting Coronavirus Economic Impact and Recovery Options.” , May 7, 2020.

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